217. Is Reeves To Blame For The Budget Hole?

26:12You may say that you weren't making very firm recommendations of what she should do. But I have to say, having read your report, you are pretty clear that she should not restrict tax relief on pension contributions to the lower the basic rate of tax. That was clear. Explain why you think that would be such a bad idea, because of course, it would raise quite a lot of money if she did that. Yeah, my advice was worth saying, just for clarification, I'm not taking a stance on what she should do because there are choices. I think there are definitely things she shouldn't do because it's really hard to justify.

26:47And I think pensions tax relief falls into that bucket. I think the thing to think about with pensions is that you have money flowing into pensions and money flowing out of pensions. And I think you could reasonably tax that money on the way in or on the way out. And we could have a great technical debate about which one of those is better, but they would both be perfectly reasonable things to do. from a sort of tax design. But you're saying you should only tax that income once is what you're saying. But tax it once, yeah. So basically what I don't want the government to be doing because it's inefficient and stops people saving is taxing money on the way in and on the way out.

27:20And when you hear debates about let's cap upfront tax relief, people don't automatically talk about, well, also let's cap tax rates on the way out. They want to have their cake in it. They want to cap the relief on the way in and not change tax on the way out. I actually wouldn't call it a relief at all, honestly. I think the fact that it's called a relief is a problem in our system. I just think we have a system that means you have no tax on the way in, no income tax on the way in, and no income tax on the way out. That's not a relief in my mind. That's just how we tax pensions. Where there is a relief is for national insurance contributions for pensions.

27:53So pensions don't get national insurance contributions for the most part. There are a couple of exceptions, but on the way in, all the way out. So if you wanted to put more tax on pensions, I think you could make a case for saying we should put national insurance contributions on kind of on the way in on the way out and we could talk about how you do that but but for the income tax treatment I think it makes it just doesn't make sense to me to think about taxing people on the way in and on the way out. So can I just ask you because I was really interested in your proposal or option I'm not saying it's a proposal you've explained to me that these are options all right but you had this option you pointed out that it looks anomalous that on the employer contribution to an individual's pension, which is broadly income, we should be clear about this, this is basically income, no national insurance is payable.

28:52And you suggested that maybe a 1 % levy on the employer's contribution might be a rational thing to do. And I see the logic of it. I guess my concern would be that the government, and many would say absolutely rightly, has faced a lot of criticism from the way that it pushed up employers' national insurance only a year ago, and thereby increasing the cost of employing people. I think many people would say, if you now say, even if it's only 1%, there's a new 1 % levy on employers' contributions to pensions, they would say that's another tax on employment. And, you know, right now, when the employment market is very weak, that would be a very bad thing to do.

29:46Yeah, so I think the way to think of it is, I mean, look, obviously there's a politics here about how people feel about, you know, employer national insurance. I mean, there's currently there's a big subsidy to pension savings and it's a big subsidy related to employer pension contributions. Remember, I think it's a name that's a bit misleading in some sense. So many people make their own pension contributions, but they do it by agreeing with their employer. They do it through salary sacrifice. So you agree with your employer that they will reduce your salary by a certain amount and they'll put that money into a pension.

30:18And that's an employer pension contribution. But it's very much decided by the employee how much that employer pension contribution is. So part of your question is really who would who would bear the burden if you put the tax on? Would it be employers taking the hit, not wanting to employ people as much? Or actually, would it just be savers who are seeing their saving their incentives to save reduced? And we can have a debate about how much do you want to subsidise pension savings. And if you want to subsidise as much as now, don't change it. But if you want to reduce subsidy, that would be the way to.

30:48One thing we could do now that would maybe help for the future, at the moment we have a very, in my mind, bizarre situation where the degree of the subsidy given to these employer pension contributions, the salary sacrifice ones, is determined by the employer national insurance rate. So when Rachel Reeves put that up last year, Not only did she put up the taxes on employment, she also increased the incentive to saving a pension. But not because we thought we needed a bigger incentive to save, just as an accident of the fact that these things are pegged together. So you could, for example, just say, we're going to put full employer national insurance contributions on pension contributions and introduce a new subsidy.

31:28And you could even set it at the same rate on day one, make them both 15%, but stop this automaticity, Stop the fact that when you change employer nix, you automatically change the savings incentive. That would be a parameter that over time other governments could then adjust. So that's a good example where I think there's a very large incentive to save in a pension. If you want to change that, don't fiddle around with income tax relief. If you want to reduce the savings incentive, you should choose Nash Insurance. And again, we talked about the employer bit of it. You could also take the other end of it and say, well, when you're getting a pension out, when you're getting the income, you could start levying some employee national insurance contributions on pensions in receipt.

32:11And that'd be another way to start reducing the savings incentive if you wanted to do that. Just pointing it down to the simple point you made at the beginning, which is you should either tax the income that goes into a pension and then the money you take out should be tax free. or you should do what which is what we're doing at the moment which is give tax relief on the way in um but then as is the case tax the income for pensioners um at whatever their marginal rate is um when they receive their pension which is the current system except for one aspect of it which if i'm honest with you i never completely understood but you can take out 25 of your pot tax-free.

32:59And that seems to break your sort of golden rule, as it were, of how you should be taxing pensions from sort of, in a sense, birth to death. I mean, so do you think, actually, if she wanted to raise some money and she wanted to do it in a fair way, she should just abolish, you know, that total tax break for when you're allowed to take money out of your pension, Paul? I'm glad I was avoiding mentioning it because I thought it was getting a bit complicated, but I'm pleased you mentioned the 25 % tax-free. So look, I think the don't tax on the way in, tax on the way out, you should think of as like the baseline system, the system that doesn't discourage or encourage savings at all.

33:39The 25 % tax-free is kind of the subsidy that tries to incentivise, does incentivise you to put money into a pension. And I think we could debate, again, it's a choice about how much do you want to incentivise people to put money away for retirement. I think it makes sense to have some subsidy for that because people are locking it away and you want them to provide for themselves in their older ages and it's a question about how much. Another thing I'd observe about the 25 % tax-free, a funny feature of it, I mean it's a very salient part of the system. Lots of people know about the 25 % tax-free if they have no idea about the rest of the system.

34:11It's an enormous amount of money and it's, you know. But interestingly if you're a higher rate taxpayer in retirement it is very, very generous to you because you save lots of money. If you're not a taxpayer in retirement, useless, absolutely useless. So even if you kept 25 % tax free, I think there's a pretty good case for, I won't get into the details, but reforming it so that for a basic rate taxpayer, you keep it kind of as it is, but I would give it, use it, do it as top ups rather than a 25 % tax free. Basically try to take some tax relief away from higher rate payers and sort of give a bit more to the non-tax payers to level it out a bit, rather have a system where it's worth much more, the higher rate tax pay.

34:51I would reform the 25 % tax-free. But again, it's a policy choice as to how much do you want to get people saving into retirement. This thing that a lot of people debated, in fact, including you, which is slightly reform the VAT system, we have very large numbers of products that are not subject to VAT. if you imposed, let's just see, even a very low VAT rate on food and books and children's clothes and all of that, which are currently nil rated, would that have, in your view, a significant impact on the rate of inflation such that any sensible chancellor would really worry about that in the short term?

35:34And obviously, there is something else they should be worrying about, which is it'll be much less affordable for people on low incomes. It'll definitely squeeze living standards for those on low incomes. So do you think actually it should be a realistic option? I mean, I slightly feel, although that seems to me to be a very rational reform in the medium term, this is just not the moment. So I think in the medium term, I think a great place for us to get to in this country will be to get rid of all zero rates and lower rates. I would put 20 % VAT on or whatever rate you want to pick on everything.

36:04And if you did that, you could actually, you could increase benefits. So universal credit, for example, for lower income households, you could do some other reforms. So that basically, however much money you want to raise and however you want to redistribute it across people, you could do it better. Lower rates of VAT are not good ways to help poor people because people like you and I buy food and children's clothing and we get bigger cash benefits from that. So that should be the long run end goal. At this moment in time, I think the inflation issue is a concern because ordinarily the Bank of England would just look through that kind of temporary inflation, but it's worried that inflation is high and maybe a bit sticky.

36:39So you might want to worry about that. Of course, the question of how much inflation would it cause would depend exactly on how much you did. If you put a big VAT swag on all food, you'd get quite a big effect. If you just did children's clothing, you'd get a smaller effect. Of course, you'll remember too, back to George Osborne's Omnishamnall budget back in 2012, where he tried to put a bit of VAT on pasties. I think the lesson from that is that actually often doing bigger things is easier. If you just pick out cakes or kids' trousers or whatever, you look like you're picking on something and that just goes down like a lead brick.

37:13I think it's better to make a kind of a coherent plea for we're reforming this system, we're doing something bigger for a principled reason, rather than saying like, well, I've scrabbled around and I've picked on kids' clothing and processed food. So I don't think it's the right time to be pushing up on inflation. And I think trying to do something that's small enough to not affect inflation gets into the political difficulties that then you've picked on a group. So it's not where I suspect we'll see much action. In fact, Rachel Reeves was talking this week about maybe cutting VAT on domestic energy, which I always think would be the wrong way to go.

37:47But I don't think we'll see increases in that. We need to take a short break. Don't go anywhere. I want to talk to you about welfare reform, among a couple of other things, in just a minute. This episode is brought to you by Google. Now, small businesses are the backbone of the UK economy. But most owners are stretched, juggling rules to keep things running. They need tools that work. That's where Google's AI helps. Take Kent Brushes. They've manufactured hairbrushes since 1777 and they remain family owned. Zoe Crosby, head of PR and partnerships, is busy juggling the demands of running a global brand with family life.

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39:35Welcome back to The Rest Is Money with me, Robert Perston. I'm delighted. Helen Miller, the IFS, is still with us. One of the, I guess, almost most upsetting bits of your Green Budget report relates to young people and the sheer numbers of young people who are in receipt of a whole variety of different elements of public support. And the bit of it that I found most upsetting was the data that shows that despite many billions of pounds going to them in extra benefits and educational support of various sorts, nonetheless, by the time they become young adults, they're not in work. and it's a system that's very expensive, but it doesn't appear to be improving the life chances of these people.

40:40So do you want to just, first of all, just talk me through the problem as you see it? Sure. So there's been a rise in the number of children and young people who have various forms of either special educational needs or disabilities or broader health conditions. and there are two types of benefits that are given to young people in this situation one is a cash benefit so the child disability living allowance and one is kind of more of an educational benefit so you get you can get a statutory right to educational support through through a mainstream or a special school and spending on as we've seen more children moving into these categories of need we are seeing spending increase and i think it's fair to say we don't know exactly what's happening there in the sense that I think it's widely thought that at least part of that is due to a greater recognition of children with needs.

41:35So there've always been children with needs there. We're now better at picking these children up, identifying them and getting support to them. So part of it's kind of a good news story, if you like, that we're finding these children. It's not good if the intervention is not actually ultimately helping these children. Sure. But just in terms of finding them and finding that they have a identifying in need is all I'm saying. If you identify that there are children with needs, that's a good place to start. right um but i think we also don't know to what extent there has just been an overall increase in needs and increase in the number of children who have for example speech and language difficulties when they first enter the school system um i absolutely agree with you i mean one of the um kind of sort of a bunch of depressing statistics that i carry around with me but one of the ones about you can look at children who are struggling and not just actually not just the children who are in the most severe definitions of need but children who are struggling at five continue to struggle when they're 15 16 and those children who are struggling at 16 often struggling early adulthood too.

42:26I think I'd be a bit careful that it doesn't mean the system's not doing anything good, of course, because what's the counterfactual? What would have happened without that support could have been even worse. But I think big picture, the fact that we have so many more children now having an identified need, I think we have to think about is the system delivering what it could? How do we deliver this support? It's now a more mainstream issue. Mainstream schools are not all well geared up to be delivering support for these kinds of children and support can't stop at the school gates it's about a broader set of things that are happening in children's and families lives so i think what's needed really is a the government to take a good look and i would put these both systems together i would think not not as in join them up but think both about what support do you get at the school in within the school gates and what support do you get at home and not and not just think about them as two completely um separate systems um i don't need to look at that system properly the government needs to look at that system and think about you know which children do we want to support for which conditions how best to do that when do you need to have special provision in a special school or when do you need to have it be brought into the mainstream if you're bringing it into the mainstream how do you make sure that teachers have the resources and the training that they need that's a big thorny meaty issue it's also worth saying with the special educational needs and disability system that's the bit that goes through the school system everyone's unhappy with that system the government sees the rising bill Local governments are seeing a really huge bill.

43:50And actually, just as an aside, those bills are currently being held off balance sheet by councils. They're racking up billions in deficits. The answer here can't just be, well, we'll just cut entitlements. I mean, I guess you could do that. But I think more you need to think about what's the system trying to do? Who do you want to support? How do you want to support them? Do you want to do more of it through mainstream schooling rather than just have currently basically sort of pots of money follow specific. children and that can be right in some cases but you might want to think about actually putting funding into schools so that schools can set up broader systems and plan over multiple years but these are all big thorny issues so the government i think is going to want to is going to look at it but it's not going to be um easy to fix uh the kind of to make sure that young people get good outcomes nor is it going to be easy to just you know quickly slash how much we're spending i don't think no and and to get back to the you know the by sort of introduction to this part i mean look there may be ways in which you could save some money i mean we all know stories you know i had a sort of relation who was being paid a colossal sum of money uh to ferry uh a kid with special needs 30 miles there and back every single day because the nearest school that could cope with this young kid was 30 miles away.

45:15And that was, I mean, you know, was nice for this person. It was a job, but, you know, it doesn't seem a very efficient use of taxpayers' money. This young person couldn't go to a school nearer where they live. And this is apparently a part of a very widespread pattern. So you can see how there could be efficiencies made. But broadly, to get back to where I started, if it is the case that there is just not enough progress for these young people for all the support they're giving, it's very difficult to argue that any reform is going to cost the government less. You know, it may be an inefficient system, but broadly, if you're looking at people, you know, looking at young adults who currently face a bleak future because they've still got these conditions that make it extremely hard for them to function and have a job and have a happy life, then we've actually got to think about provision which isn't going to be cheap that helps a bit more effectively with rehabilitation.

46:20So I mean, I may be wrong about this, but it doesn't feel, even though billions and billions and billions are being spent on this and the bill is going up year after year, it's not obvious to me that you know rational reform delivers savings in this area another thing to know that we did in this piece of work was look at children who are getting the kind of child disability allowance follow them through into early adulthood many of them move on to getting adult disability payments so therefore as you have more of these children who we have we have lots of children who are coming up through the system they're gonna they're gonna age they're gonna probably move into the the other system so that that's a cost pressure that won't go away when they're 16 I think you know very broadly and bluntly speaking I mean if you wanted to save money from this system what do you do so you either make the system more effective more cost effective so you can provide the same level of support maybe better support at a lower cost maybe you move it into mainstream schools so you're not going to specialist schools or you find ways to reduce the cost of transport or you know to make the support just more effective more productive or you cut into our problems.

47:26They're kind of, if what you're thinking about is money saving, then they're kind of the only two paths you have really, right? You just get more productive or you do less. And doing less can mean you do less for everybody or you can choose some children who don't get support anymore. And they're the kind of choices we have. And of course, I think everyone has an incentive to try with whatever money you're spending to try to make it as effective as possible. And not just in the moment in time where you take a 14-year-old, let's help support that 14 year old through the next term at school but trying to ensure that they have they're building up the kind of skills and resilience or everything else they need so that as they move into adulthood there is a pathway for them um and whether that you know there's a pathway into some form of training that might eventually leading to a job for you know i think there's a um in part i think it's part of actually a bit of a broader problem in our country we have a very well-worn path for children who are um you know go a levels into universities a very well-worn path into a job our further education system has been neglected for an awfully long time.

48:25Yeah, Steph will be very sad she missed you saying that because she does make this point very regularly. Now, I just want to finish off and I want to take us back almost to where we started, which is the challenge of keeping the confidence or indeed boosting the confidence of the government's creditors, those who lend to the government. Now, again, in the Barclays written bit of your recent report, that chapter says, if the government could come up with a credible path to reduce in particular disability benefits that would increase the confidence of lenders and you know that might get you into the kind of virtuous cycle where actually the cost of borrowing came down a bit the government's interest bill came down a bit and there was actually more money uh to invest in in public services or indeed potentially i suppose in lower taxes, although I don't think that's all the cards for the time being.

49:18And so I guess, given that we saw that rebellion by Labour MPs that made it impossible for the government to force through that initial set of disability payment reforms that they were hoping for, what could she say that was credible and deliverable in your view? So look, I think you're right that on disability, the difficulty that the government obviously have is they tried to make cuts here. They didn't get it past their backbenchers. They're having now a review of this stuff. I think it's going to matter politically that they sort of first do the review, have a principled reason to reform, and then maybe save some money.

49:57I think coming back with just, I'm going to cut this, won't be credible with the backbenchers or with the market. So I think disability per se is going to be very hard in my opinion. But I think stepping back from that, I think what's really important to the creditors, to the people lending the government money, is the credibility aspect. And there are different ways to, I think, build credibility. So what wouldn't be credible is just to say, in three or four years, we'll pencil in some spending cuts. I won't tell you what I'm going to cut yet, but when I get there, I'll work it out. That's not very credible.

50:24And of course, markets might like that the government did something that was seen to be politically hard, regardless of what it was, just because the fact that you've done something politically hard means you have the ability to use your majority and to burn through some political capital in order to do something. So I don't think, I mean, frankly, looking at disability, you're looking at, you know, three, four, five billion. In the grand scheme of things, that's not, it's not the money, it's not the pounds, billion per se, that's going to make the market feel a way or another. It's the kind of, it's a signal of, did you do something politically difficult?

50:55So do I think they're going to do something politically difficult on disability? Probably not. But, you know, I think there are other things you could do. What they will do on welfare goes in precisely the opposite direction, since, you know, we all expect them to lift the two-child limit on universal credit payments, because certainly an overwhelming majority of their own MPs think that is the best way to tackle child poverty. and that will cost, I mean, you know, depending on quite how they do it, but it could cost, you know, three to four billion pounds, quite a lot of money. And broadly, if they just did that, arguably that would undermine the confidence of investors because they would think, despite the big majority, this is a government that is incapable of making what, you know, investors would say are the hard but right choices.

51:50So, I mean, I'm not sure how the market would, I'm not sure the two-trade limit per se would worry them if they got rid of that too much. I think, again, I think it's the overall package that's going to matter and how credible the overall package is. What would an overall package be that doesn't tackle the area which even the government accepts is rising too fast, which are disability payments? Imagine that they can't or they don't want to tackle disability or pensioner benefits, actually. Obviously, winter fuel payment was actually a relatively small change they couldn't get through. If you think that they can't do that, what else can they do?

52:24Well, they could make sure that they change taxes in a way they haven't just scraped around for some small damaging tax. They did something that was a bit more principled or a bit, you know, not too damaging. They could build some more headroom because the market's going to worry less about whether you can deliver cuts if you've got more headroom in future. So they know you're back here in six months time. I wonder if they can start looking at some of the longer term issues we've got coming. So to give you a concrete example, we know that because the government wants to get rid of cars, non-electric cars, we're going to lose motoring taxes.

52:55Actually, what if you started saying, I'm going to have a plan for road taxing. It's going to come in at a very small level. It's going to increase over time. That might not show up at all in the five year sort of budget scorecard for the government on what happens in five years time. That'd be a real signal that I know this problem's coming. I've got a credible plan for it. That money, that 40 billion or whatever, it won't be lost. It'll be replaced. Maybe the triple lock, could you start changing triple lock towards something more sensible? So doing things that won't necessarily have an impact today, but would signal that you know these problems are coming and that you can do something that might build sort of long-term credibility for fiscal sustainability.

53:32Maybe that helps. I'll let you into a secret. They're definitely not going to tinker or say anything about the triple lock. That is simply not going to happen. But actually, there is another thing. We better finish in a minute. Actually, there is another thing that you mentioned in your report, which it'd be interesting to see whether this time they have the courage to do it. But I guess this would be something that might build a bit of confidence that they're prepared to do tougher things, which is your report does mention that this is surely the year when they uprate fuel duty properly in line with the so-called escalator.

54:10and they take away, you know, the 5P subsidy. That would raise, you know, and that would be the first time, I mean, almost forever. Since 2011. But it wouldn't raise anything. The problem is, at the moment, the public finance forecasts assume it will happen. But every single budget, despite the fact it's always pencilled into something that will happen, they never do it. So it's a symbol of them being prepared to do something. But it's also, of course, the market, I think, now expects they won't do it. So it's kind of one of these, the public finances assume the money's there. the market thinks oh no no she won't do it she'll get away with it so yeah we're in this ludicrous situation where the public finances just don't reflect what everyone thinks that's actually going to happen but it'll be it'll be one to watch i mean i'd be surprised i'd be surprised if she doesn't just uh do what every chance has done since 2011 and say you know not not this year we'll do it next year we promise um but we'll see oh my god you say well it is one of those it is one of those where you i don't know anyway i don't even want to say what i think if she does do that again but who knows she probably as you say she probably will in the end do what all chancellors have done in recent years i would call them pusillanimous but that would probably be me taking sides in a way that i shouldn't take sides um so there we are uh shall we leave it there there's been so much that we've covered absolutely gripping doubtless you and i will be talking a little bit more in the coming weeks uh as we get to budget day and then we have to make sense of Thanks again, Hannah.

55:35All the best. I look forward to it.